Creating a safety net under a family's life insurance coverage can be quite an undertaking.
Many consumers find that choosing a life insurer can be their toughest financial chore. Unlike shopping for home mortgages, stocks or mutual funds, the decision on an insurer begins a relationship that can bind the consumer with a company for decades.
Industry officials and independent analysts stress researching the financial strength of an insurer. Many experts, however, acknowledge the difficulty in predicting what companies -- no matter how strong the financial reviews they get today -- might survive for 20 or 30 more years. That's when many of today's insurance buyers will cash in on their coverage.
By stealing a concept from the stock market investing rule book -- diversification through buying coverage from multiple insurers--consumers can lower the risk of losing all their coverage.
This tactic can be reassuring. Consider that people who bothered to research Executive Life Insurance and First Capital Insurance, both recently seized by state regulators, would have found the insurers getting top marks from some rating agencies in recent years.
Deep-pocketed investors are frequently advised to buy two or more life insurance policies. And in big-dollar court settlements, numerous annuities are often bought to assure that payments to the victim don't stop because of one insurer's problems.
"It can't do anything but help," said Eleanor Etter of Fidelity Life Insurance Co. of Boston. "Diversification is not a ridiculous concept to bring to insurance."
Talk of spreading life insurance business among various carriers does not sit well with other industry executives. They argue that buying policies with the top-rated, conservative members of the industry is enough protection.
"Generally [splitting insurers] is not particularly wise," said James Jackson of the Los Angeles-based Transamerica Life Insurance Cos. "Ratings are not perfect. But it isn't impossible to find a quality company with quality assets on its books. And you must recognize the expense [of diversifying]. Your payments will likely be higher."
Martin Weiss, whose West Palm Beach, Fla., company rates insurers' financial health, says industry officials are being hypocritical when suggesting that consumers pick just one insurer. "The industry argues how strong they are because of their diversification of investments. . . . Why should they object if the public wants to do the same? What's prudent for others' investments makes perfect sense for buying insurance."
Unlike the relative ease of buying a mutual fund to get into a pool of various stocks, higher costs can make obtaining a portfolio of insurance coverage impractical for modest-sized policies.
The standard life insurance product comes with several setup and annual costs that would be multiplied when purchasing additional policies. Also, insurance gets cheaper on a per-dollar basis as the size of the coverage grows.
An example provided by the Orange County, Calif., chapter of the American Society of Chartered Life Underwriters and Chartered Financial Consultants shows part of the cost of diversification. For a 35-year-old, non-smoking male, three $50,000 policies from three top-rated companies were a combined $13 to $35 a month more expensive that a single $150,000 policy from the same three insurers. However, through age 65, a holder of three smaller policies would have death
benefits and cash value larger than two of the three bigger policies surveyed.
There are also logistical problems, notes Ivan Bishop of Pacific Mutual Life Insurance Co. in Newport Beach, Calif. Some insurance agents can sell the products of only one company. And even if you put together a package of numerous policies from various companies, you must juggle multiple paperwork. "Diversification has been a trend for several years . . . that may become more popular in current circumstances," Mr. Bishop said.
After the mathematics and logistics, it comes down to one decision: Is the added cost worth it? The choice is similar to the stock market player who must weigh added brokerage commissions -- which favor larger purchases -- when choosing to buy several stocks rather than one.
Diversifying among insurers "can't be a blanket answer for everyone," Mr. Weiss said. "It needs to be looked at on a case-by-case basis."
Investors thinking about annuities -- life insurance products that guarantee an income stream for life -- can also benefit from diversification, experts say.
Making the wrong decision on an annuity can be extremely damaging. While consumers are contributing to the annuity, they can switch to other companies with a simple transfer (some exit fees may apply). Once a consumer begins regular withdrawals from the annuity, however, there is no way to change coverage.
In the case of annuities, investors will find the cost difference between small and large accounts to be much less a factor in making the decision. Often there is a small annual fee and a management fee set at a certain percentage per dollar $l contributed. This would hurt only an investor trying to divide a very small nest egg.